Why is the Federal Reserve poised to leave interest rates unchanged despite persistent inflation?

• Expectations overwhelmingly favour an interest rate hold by the US Federal Reserve at its October meeting. 
• A December rate increase remains a strong possibility in market pricing.
• US Dollar volatility could pick up in response to Fed Chair Warsh’s press conference comments.

The monetary policy outlook for the rest of the year will be in focus as the United States (US) Federal Reserve (Fed) delivers its Interest Rate Decision on Wednesday, after another crucial policy meeting that could offer important signals on the central bank’s approach towards year-end.

The broad market consensus is for the Federal Open Market Committee (FOMC) to retain the policy rate within the 3.75%-4% range after September’s announced increase of 25 basis points (bps).

With the CME FedWatch Tool assigning only about a 9% probability to higher borrowing costs, a hold is almost entirely reflected in market prices. Attention could therefore turn to Fed Chair Kevin Warsh’s post-meeting press conference, where his remarks may clarify the rate outlook and influence the US Dollar’s (USD) value.

At an International Monetary Fund (IMF) event earlier this month, Warsh reaffirmed the focus on achieving price stability, while saying he did not believe in “pre-judging meetings.” Investors took that remark as a reason to all but rule out an October rate increase. This was despite September’s US Consumer Price Index (CPI) exceeding expectations, as annual headline inflation accelerated from 3.4% to 3.7%. 

With a rate change at the forthcoming meeting largely ruled out, Deutsche Bank economists expect the tone of the Fed’s communication to take centre stage. They observe that “the interest will therefore be in Chair Warsh’s press conference and how the Fed balances still-elevated inflation and solid growth against the recent tightening in financial conditions.” In their assessment, the policy message will be evaluated on whether the Fed convincingly recognises stubborn price pressures and strong economic activity while accounting for the effect of tighter market conditions on the wider outlook. 

What time is the Fed rate decision, and what could it mean for EUR/USD?

Wednesday brings the Fed’s Interest Rate Decision alongside the release of its Monetary Policy Statement at 18:00 GMT. Afterwards, Fed Chair Kevin Warsh’s press conference will begin at 18:30 GMT.

September’s updated Summary of Economic Projections (SEP) indicated that 12 of 18 officials anticipated one further 25-basis-point (bps) increase this year. Of the remaining members, four expected two increases, while two foresaw no further hikes.

The June dot plot, which forms part of the SEP and sets out policymakers’ interest rate forecasts, had indicated an increase of just 25 bps in 2026. The projections then pointed to a 25 bps reduction in 2027 and a further 25 bps cut in 2028.

Market pricing leaves scope for the USD to strengthen again if Warsh departs from his earlier IMF remarks and points to a December rate increase on account of persistently elevated inflation. The CME FedWatch Tool puts the probability of the policy rate being unchanged at year-end at only about 17%. Such a signal could place EUR/USD under immediate selling pressure. However, the European Central Bank (ECB) also delivers its policy decision on Thursday, meaning any decline in the pair driven by a hawkish Fed message could stall ahead of that announcement.

MUFG/BTMU analysts point out that “the final FOMC meeting of the year is not until 9th December,” while observing that “the signs of tightening financial conditions continue to build,” which leaves “certainly a chance that Fed rate hike expectations for December could ease.” Their assessment is that “the willingness of Warsh to signal the Fed remains on the path highlighted by the dots will be important.” They further state that “in circumstances of tightening financial conditions and bond market volatility in Europe we would assume the Dollar will remain underpinned, and the risks remain skewed to the upside.” 

By contrast, the Greenback could lose ground against other major currencies if Fed Chair Warsh plays down recent inflation developments and avoids indicating a December rate increase. A renewed refusal to pre-judge the year’s final meeting could discourage investors from fully pricing in a hike, allowing EUR/USD to move marginally higher. Even so, a marked improvement in inflation figures or a very poor employment report would likely be needed before market participants rule out that possibility. 

The apparent resilience of EUR/USD conceals a less favourable underlying trend for the single currency, according to Commerzbank’s Thu Lan Nguyen. As she observes, “short-term inflation expectations have risen more strongly in the Euro Area than in the US,” but “higher inflation expectations are currently not being offset by a corresponding shift in relative interest-rate expectations.” Commerzbank argues that this divergence “is, in principle, a negative signal for the Euro,” because market pricing does not reflect sufficient policy tightening to offset rising Euro Area inflation expectations. That could expose the currency to weakness if sentiment deteriorates. 

For the short-term technical picture in EUR/USD, FXStreet European Session Lead Analyst Eren Sengezer offers the following assessment:

“The near-term technical outlook for EUR/USD highlights a bearish bias as the pair remains in the lower half of the Bollinger Band on the daily chart and the Relative Strength Index stays well below 40. On the downside, 1.1130-1.1100 (lower limit of the Bollinger Band, static level) aligns as the immediate support level ahead of 1.1000 (psychological level, static level). If this latter support fails, a deeper pullback toward 1.0750 (static level) could be witnessed. If the daily RSI falls into the oversold territory below 30 and EUR/USD stays below the lower limit of the Bollinger Band, investors could wait for a technical correction before committing to an extended decline.”

“Looking north, an interim resistance area could be spotted at 1.1260 - 1.1300 (static level, upper limit of the Bollinger Band). In case the pair manages to stabilize above this region, the 50-day and the 100-day Simple Moving Averages in the 1.1420-1.1440 area could become the next difficult hurdle to clear.”